European Journal of Sustainable Development (2019), 8, 1, 350-364 ISSN: 2239-5938 Doi: 10.14207/ejsd.2019.v8n1p350 On the Impact of Globalization on Financial Development: A Multi-country Panel Study Mehmet Balcilara, b, c, * , Hasan Gungora, Godwin Olasehinde-Williamsa ABSTRACT In this paper, we examine whether globalization effects financial development by generating incentives for institutional reforms, and therefore, enhance economic growth due to increased financial development in addition other channels. Specifically, we examine the relationship between globalization and financial development for a panel data of 36 countries over the period 1996-2016, using panel data estimation methods. In addition to overall globalization, we also consider economic, political and social subdimensions of globalization. Moreover, not only the financial institutional development but also its access, depth and efficiency dimensions are considered. The study also controls for several other covariates affecting financial development. The shows that all measures of globalization strongly enhances financial institutional development and its subdimensions except the efficiency for which the evidence is weaker. Thus, globalization has generated incentives for institutional reforms, and therefore contributed positively to financial institutional development and economic growth. Keywords: Globalization, Financial Development, Panel Data 1. Introduction Globalization and its impacts on the economy have been one of the main concern of the scholarly researchers over the last three decades. Vast amount of research shed light on the various aspects of globalization and its impact on various sectors and the overall performance of the economies. The literature has generally emphasized that the link between financial development and the globalization has become stronger over the three decades as globalization stimulated institutional reforms that promote financial development economic growth. Thus, in additional to its growth enhancing effect through trade, globalization might further enhance economic growth indirectly via its effect on financial development (Mishkin, 2009). This has made the policy makers to reconsider their policies in order to use advantages and increase the economic gains from the benefits of the globalization with the ultimate goal of sustainable growth. Globalization provides several important benefits for those economies who are getting more integrated into the global economic system. First, it helps for the development of financial sector. Second, it facilitates technology and knowhow transfer from developed economies to developing economies. Third, it provides lower cost of capital for the domestic economy via capital mobility. Fourth, it helps for the accumulation of savings domestically. Fifth, it provides access to those markets that requires improved | a Eastern Mediterranean University, Northern Cyprus, via Mersin 10, Turkey. b Montpellier Business School, Montpellier, France c University of Pretoria, Pretoria, 0002, South Africa * Corresponding author. E-mail: [email protected]. M. Balcilara, H. Gungor, G. Olasehinde-Williams 351 specialization in production. Sixth, it enables improvements in macroeconomic policies and institutions via higher competitive pressures from global world.1 The first through fourth effects are known as direct channels through which globalization enhances economic growth. The last two are the indirect channels (Prasad et al., 2003; Schmukler and Abraham, 2017). However, globalization is not free from the risks that can destabilize financial markets and eventually slow down the economic growth. In some cases, high degree of global integration may pose risks that are not directly originating from the domestic economy but transmitted from another economies as it was in the case of 2007 – 2009 global financial crises. This was the result of global risk sharing in global financial markets. Thus, the nexus between globalization and its impacts on the domestic economies in general and financial markets in particular is an temporally question that should be examined empirically. Financial development have also received great attention both from academic and policy circles. By definition, financial development refers to better mobilization of savings in the form of accumulated liquid assets, acquiring information about investments and allocation of resources, exercising corporate control by monitoring the managers, facilitation of risk management and facilitation of trade and contracts (Levine, 1997). The initial studies were mainly focused on the possible links between financial development and growth both theoretically and empirically. The main research question was whether financial development had any leading role on economic growth and vice versa. Furthermore, some studies also attempted to identify the possible channels through which financial development effects growth. The findings until now can be best described as mixed. Ang (2008), Beck (2011) and Paşalı (2013) present an extensive survey of the substantial amount of research findings on the topic. Given the importance of globalization for integrating a country to global economic system and the role of financial development on the growth, it is important to investigate the possible effect of globalization on financial development. In other words, there may be channels through which globalization effects financial development. Mishkin (2009) argues that institutions are important establishments in achieving successful financial development. That is, financial markets cannot perform their functions well without having well established institutions which is essential for economic growth. But this is not an easy task to achieve since it takes time, energy and resources to build sound institutions that can adapt to local conditions. Furthermore, interest group theory of financial development proposed by Rajan and Zingales (2003) argues that local incumbents usually oppose the necessary reforms to build up sound institutions. Thus, it becomes even more difficult for emerging economies to successfully implement reforms that will help to construct a well-functioning financial system, which will contribute to the economic growth. Mishkin (2009) further argues that there is no standard recipe on the exact mix of institutional characteristics that best promotes financial development and thus economic growth. However, the factors that must be in recipe are strong 1 Prasad et al. (2003) states that improvements in macroeconomic policies and institutions via higher competitive pressures from global world can also be called the “discipline effect”. © 2019 The Authors. Journal Compilation © 2019 European Center of Sustainable Development. 352 European Journal of Sustainable Development (2019), 8, 1, 350-364 property rights, a legal system that enforces contracts quickly and fairly, elimination of corruption, high quality of financial reporting and information, good corporate governance, and sound prudential supervision and regulation of the banking system. Therefore, he argues in the same lines as Prasad et al. (2013), i.e., globalization, by the discipline effect, improves institutions with a given mix, so that it helps financial development to further improve and thus contribute to the economic growth. This study examines the impact of globalization on financial institutions development in a panel of thirty-six countries. Through this study, we attempt to provide empirical evidence for the Mishkin (2009) hypothesis using up-to-date panel data estimation techniques. Our study differs from previous studies in the following three ways. First, this study is the first to consider the various dimensions of financial development (access, depth and efficiency) while testing the Mishkin (2009) hypothesis. Second, because globalization is a multifaceted concept with economic, political and social dimensions, our study accounts for all these three dimensions. Third, we adopt a panel framework that is robust to challenges posed by cross-sectional dependency and country- specific heterogeneity. The rest of the paper is organizedd as follows: Section 2 provides a review of the relevant literature. Section 3 presents the data, empirical model and econometric methods followed, Section 4, which presents the empirical findings. Finally, Section 5 concludes. 2. Empirical Literature Review There are limited amount of empirical research on the Mishkin (2009) hypothesis. Law and Azman-Saini (2012) using banking sector and stock market development indicators examined the effect of institutional quality on financial development in developed and developing countries. Their findings support the idea that high quality institutional environment is important in explaining financial development. By using dynamic panel system generalized method of moment (GMM) estimation, they showed that the banking sector and the stock market respond differently to institutions and governance. Law et al. (2014) analyzing the East Asian case, found that globalization has a significant causal influence on institutional quality, and institutional reforms have in turn facilitated and supported financial development in particular of the banking sector. Furthermore, their findings reveal that globalization has a favorable causal impact on stock market but without going through the institutional quality channel. Falahaty and Law (2012) studying nine Middle East and North Africa (MENA) region countries